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Globalization and Political Structure∗
Gino Gancia, Giacomo A. M. Ponzetto and Jaume Ventura
February 2016
Abstract
The first wave of globalization (1830-1914) was accompanied by a decline in the
number of countries from 125 to 54. The second wave of globalization (1950-present)
has led instead to an increase in the number of countries to a record high of more
than 190. This paper develops a theoretical framework to study the interaction be-
tween globalization and political structure. We show that political structure adapts
to expanding trade opportunities in a non-monotonic way. Borders hamper trade. In
its early stages, the political response to globalization consists of removing borders by
increasing country size. In its later stages, however, the political response to globaliza-
tion is to remove borders by creating economic unions, and this leads to a reduction
in country size.
JEL Classification: D71, F15, F55, H77, O57
Keywords: Globalization, political structure, size of countries, international unions.
∗CREI, Universitat Pompeu Fabra and Barcelona GSE. E-mail: [email protected], [email protected],[email protected]. We thank Marta Santamaria and Jagdish Tripathy for excellent research assistance.We acknowledge financial support from the European Research Council (grant GOPG 240989), the SpanishMinistry of Economy and Competitiveness (grants RYC-2013-13838, ECO2014-54430-P and ECO2014-59805-P), the Generalitat de Catalunya (grant 2014 SGR 830) and the Institut d’Estudis Autonòmics.
1 Introduction
In 1820, the world was made up of 125 sovereign states. By the end of the first wave of
globalization in 1914, the number of countries had fallen to 54, less than half of the initial
level. The interwar period witnessed a reversal of these trends: trade collapsed and the
number of sovereign states rose to 76 by 1949. Until then, political and economic integration
had proceeded together. Yet, the end of World War II marks the beginning of a new era.
The second wave of globalization that started after 1950 has led trade between nations to
flourish to levels never seen before. But this time the process of economic integration was
accompanied by different changes in the world political structure. On the one hand, the
number of countries has risen to a record high of more than 190, suggesting that more trade
is now accompanied by political fragmentation. On the other hand, however, there has been
a proliferation and growth of international treaties and unions aimed especially at fostering
economic integration, such as the WTO and the European Union.
These trends are illustrated graphically in Figure 1, which shows the historical evolution
of the number of sovereign states in the world, average exports as a share of GDP and the
number of members of the GATT/WTO. The data on the number of states was obtained
from Butcher and Griffi ths (2013).1 However, counting the number of sovereign countries
in the past poses some challenges, especially in remote and underdeveloped areas.2 Hence,
in Figure 2 we plot an alternative measure of political concentration: the average land size
of “internationally recognized”countries and of thirteen major empires since 1830, from the
Cross-National Time-Series Data Archive. The graph tells a story remarkably similar to
Figure 1. During the 1800s, there was a phase of political consolidation in which countries
and empires expanded their territories. But this trend reversed in the decades after World
War II, which saw the collapse of large empires and a steady fall in average country size.
Why did the first wave of globalization lead to political concentration? Why did the
second wave of globalization lead to political fragmentation? To answer these questions,
this paper develops a theoretical framework to study the interaction between globalization
and political structure. We view globalization as a process by which the geographical size
of markets expands. There is wide consensus that globalization started around the mid
nineteenth century and that it was fueled by major technological advancements, sustained
1See Appendix A.1 for more details about the data.2Most importantly, the commonly used “International System”(Singer and Small 1966), including coun-
tries with international recognition, grossly underestimates the number of independent political entities inthe 19th-century developing world.
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Figure 1: Trade share (right axis), the number of countries and WTO membership (leftaxis.) See appendix for details on data.
economic growth and the adoption of market-promoting policies.3 A key premise behind our
work is that borders hamper trade, and globalization makes borders more costly. Consistent
with the evidence in Figures 1 and 2, our theory suggests that political structure adapts
to expanding trade opportunities in a non-monotonic way. In its early stages, the political
response to globalization consists mostly of removing borders by increasing the size of coun-
tries. In its later stages, however, the political response to globalization is to remove borders
by creating economic unions, and this leads to a reduction in the size of countries.
Our theory builds on the classic work of Alesina and Spolaore (1997), who argued that
country size trades off preference heterogeneity and economies of scale. Preference hetero-
geneity across space creates a force towards political fragmentation. Each relevant geograph-
ical unit or “locality”would like to have a government type that is as close to its ideal type
as possible. As the size of a country increases by adding more localities, the resulting gov-
ernment type tends to move farther away from the ideal type of each of them. Thus, the
mismatch between citizens’ideal and actual government type increases with country size.
3See Hugot (2015) and Pascali (2014) for recent papers on the onset of globalization.
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country empire
Figure 2: Size of countries (left axis) and empires (right axis). Thousand squared miles, seethe appendix for details on data.
Economies of scale create a force towards political concentration. As country size increases,
some fixed costs of setting up and running a government are shared by a growing number of
localities. Thus, the cost of the government also declines with size. Alesina, Spolaore and
Wacziarg (2000) extended this theory to allow for international trade and a border effect.
This creates another force for political concentration. As country size increases, the number
of borders declines and the gains from trade grow. Then, they modeled globalization as
a reduction in the border effect, which weakens the benefits of size and leads to political
fragmentation.4
Our theory departs from this earlier work in two important ways. The first one is our ap-
proach to globalization. Instead of modeling globalization as a reduction in the border effect,
we model this phenomenon as an increase in trade opportunities. This is more consistent
with the notion of globalization as a geographical extension of the market. Many goods and
4In a similar vein, but less directly related to our work, Casella (2001) and Casella and Feinstein (2002)study the interaction between economic and political integration in a model where public goods affects thegains from trade, while Bolton and Roland (1996, 1997) focus on the role of income distribution and factormobility. See Ruta (2005) for a survey of the literature on the economic incentives for countries to integrateor separate, and how these incentives are affected by globalization.
3
services that were traded only locally in the early nineteenth century were already traded
internationally by the early twentieth century. There are even more that are traded inter-
nationally in the early twenty-first century. Globalization effectively makes borders more
costly, as they affect a growing volume of trade. This change of perspective suggests that
globalization provides incentives to remove borders rather than to create them, and it would
lead us to the conclusion that globalization leads to political concentration.
The second and most important novelty of our theory is to recognize that the notion of
government type is multidimensional. In particular, this notion includes a full description of
the laws and institutions that govern economic and cultural interactions within a country. By
economic interactions, we mean market exchanges of any sort. By cultural interactions, we
mean “the distinctive ideas, customs, social behavior, products, or way of life of a particular
nation, society, people, or period.”5 Thus, it is useful to think about the economic and
cultural types of government.6
This distinction enriches the analysis since it expands the set of possible political struc-
tures. We can think of countries as sets of localities that share the same economic and
cultural types of government. We can then think of economic unions as sets of countries
that share the same economic type of government but not the same cultural type. Going
back to Figures 1 and 2, we can now ask: Why did the first wave of globalization reduce
the number of countries but did not generate economic unions? Why did the second wave of
globalization increase the number of countries and led to the creation of economic unions?
Once these questions have been re-formulated this way, we need only two additional (and
reasonable) assumptions to obtain our main result.
The first assumption is that the border effect is largely due to differences in the economic
type of government, while preference heterogeneity is defined mostly over the cultural type of
government. This suggests the benefits of a political structure consisting of small countries
each of them with its own distinct cultural type, and a large economic union that encompasses
many or all of these countries. This political structure would allow localities to enjoy a
5This is the definition of culture offered by the Oxford English Dictionary. This notion of a group’s cultureis quite broad. It includes not only sharing a common language and history, but also sharing common viewsabout justice and punishment, how to educate children, the size and scope of the welfare system, the needfor redistribution, and so on.
6Thus, our research is also related to the broad theory of fiscal and political federalism. The classiceconomic analysis of federalism (e.g., Oates 1972) focuses on two rationales for centralization: economies ofscale and benefits from policy coordination. Political-economy analyses have emphasized that a countervail-ing cost of centralization is the reduced ability to tailor policy choices to local tastes (Lockwood 2002; Besleyand Coate 2003; Boffa, Piolatto and Ponzetto 2015). We study the evolution of this trade-off in the wake ofglobalization and its implication for the endogenous formation of countries and economic unions.
4
government that is close to their ideal type. It would also facilitate trade by removing
borders.
The second assumption is that there are limited economies of scope when the cultural
and economic types of government coincide. Having different economic and cultural types is
akin to having two different sets of laws and institutions for market and cultural interactions
or, in short, having two different levels of government. This not only duplicates costs, but
it also introduces transaction costs across levels of government. Earlier research, and most
notably the work of Alesina et al., has adopted the view that economies of scope are so
large that the possibility of having different economic and cultural types of government is
not worth considering. We relax this assumption and allow for limited economies of scope.
The non-monotonic effect of globalization on political structure follows from these as-
sumptions. At early stages of globalization, localities take advantage of increased trade
opportunities by enlarging country size. That is, the cost of reaping the gains from trade
is paid in terms of a larger mismatch between the ideal and actual types of government.
Forming economic unions is not worthwhile since trade is small and the benefits of removing
borders this way are outweighed by loss of economies of scope. As globalization proceeds, the
size of countries increases and the cost of preference mismatch keeps growing. Eventually,
this cost is too large and it is worth giving up economies of scope. The world political struc-
ture shifts from a world with a few large countries to a new world with many small countries
that participate in an economic union. This result is consistent with the observation that
political structure reacted differently to the first and second waves of globalization.
A key aspect of any theory of political structure is a view of how localities interact. In
Section 2, we develop a stylized model of the world with a continuum of localities that are
sovereign and free to sign political contracts among themselves. Such a view of political
interactions can aptly be described as the rule of diplomacy. We show that equilibrium
political contracts take the form of countries and unions. And we describe how the number
and size of countries and unions evolves with globalization. In particular, we find that in the
early stages of globalization, country size grows and there are no economic unions; while at
the later stages of globalization, a world economic union is formed and country size shrinks.
But diplomacy is hardly the only form of interaction in the real world. In Section 3, we
allow a small set of great powers to wage war and build empires. In equilibrium, the world
is partitioned into a set of empires ruled by war and conquest and a free world ruled by
diplomacy. Interestingly, we find that our main result also applies to this world: in the early
stages of globalization, country size grows and there are no economic unions; while at later
5
stages of globalization, a world economic union is formed and country size shrinks. In both
stages, great powers choose not to build empires and instead join the free world. Diplomacy
rules. The new result now is that there exists an intermediate stage of globalization in which
great powers build empires that grow in size. These empires eventually collapse as the world
enters the third and final stage of globalization and the world economic union makes them
obsolete.7
In Section 4, we break the perfect symmetry of the benchmark model by assuming that
the world is divided into regions and that trade costs and cultural differences vary across
and within regions. We then use the model to rationalize why the process of formation of
unions tends to be gradual and often starts at the regional level. The picture that arises from
our stylized model is therefore rich and suggestive. In Section 5 we show how our analytical
results help us interpret a variety of specific historical experiences. Section 6 concludes.
2 The Symmetric World
In this section, we develop a stylized model of the world that contains the basic ingredients
of the theory: geography, markets and preferences. The model mixes these ingredients
imposing a high degree of symmetry. This allows us to derive our basic results on the effects
of globalization on political structure quickly and intuitively.
The concept of locality is a key primitive in our theory. We model the world as a set of
locations within which there are neither geographical nor cultural distances, and we label
them localities. Thus, localities consist of a group of people sharing common preferences
and inhabiting a particular territory. This approach, which is common in the literature,
simplifies the study of how peoples with different cultures interact and organize themselves
into political entities. But it is silent about how these cultural differences arose in the first
place and how they evolve over time. It also abstracts from domestic conflict.
The concept of globalization is another important primitive in our theory. Geographical
distances introduce trade costs across localities that shelter local markets. We interpret
globalization as exogenous technological change that gradually removes these trade costs
and turns local markets into global ones. In particular, we use the popular traded-nontraded
model in which the markets for traded goods are global, while the markets for nontraded
goods are local. We then model globalization as an increase in the share of traded goods.
7See Martin, Mayer and Thoenig (2008) for a theoretical and empirical analysis of the relationship betweentrade and war.
6
2.1 Basic setup
We consider a world with a continuum of atomistic geographical units called localities, l ∈[0, 1]. Each locality contains a positive measure of identical individuals. Let Wl be the
welfare of the representative individual of locality l. For short, we refer to this individual as
“locality l.”Then, the welfare of locality l is determined as follows:
Wl = WMl +WG
l , (1)
where WMl is the utility derived from the consumption of market goods, and WG
l is the
utility derived from the services provided by its government. We explain next how these two
variables are determined.
2.1.1 Markets and Trade
There is a continuum of industries producing goods, i ∈ [0, 1]. Let cl (i) be the consumption
of goods of industry i by locality l. The utility function takes the following form:
WMl =
∫ 1
0
ln cl (i) di. (2)
The choice of a symmetric logarithmic or Cobb-Douglas utility function ensures that all
localities spend the same share of their income in each industry.
The production of consumption goods requires differentiated input varieties, m ∈ [0, 1].
Define cl (m, i) as the amount of inputs of the variety m used by locality l in the production
of goods in industry i. Then, we have that:
cl (i) = exp
{∫ 1
0
ln cl (m, i) dm
}. (3)
This production function is symmetric across and within industries. Since we use again the
convenient Cobb-Douglas formulation, each locality spends the same fraction of its income
on all varieties of all industries.
To introduce gains from specialization and trade, we use a simple symmetric version of
the Ricardian model. Each locality is endowed with one unit of labor in each industry. This
unit can produce one unit of the variety with the same index as the locality, i.e. m = l; or
e−η units of any other variety, i.e. m 6= l. Since η > 0, each locality has a technological
advantage in its “own”variety. The parameter η measures the extent to which technologies
7
differ across localities and, therefore, the potential gains from specialization and trade.
We introduce both technological and policy-induced barriers to trade. In some industries,
the costs of shipping inputs across localities are negligible, while in the rest these costs are
prohibitive. As usual, we refer to these two sets of industries as traded and nontraded,
respectively. We order industries so that traded ones have low indices, i.e., i ∈ [0, τ ]. We
interpret globalization as an increase in τ , which reflects the decline of technological trade
costs.
The presence of borders also imposes costs to trade. Define a variable blm which takes
value β if there is a border between localities l and m, and it takes value 0 otherwise.
Then, we assume that only a fraction e−blm of the goods shipped from l to m arrive to their
destination. Thus, the parameter β measures the size of the border effect. To ensure that
borders do not preclude specialization and trade, we assume that η > β > 0.
A market equilibrium is a set of prices and quantities such that individuals maximize
utility and markets clear. Appendix A.2 shows that there exists a unique market equilibrium
for each possible configuration of borders. In this equilibrium, traded industries specialize
in the locality’s input variety, export essentially all of their production and import the
remaining input varieties. Thus, consumption in traded industries is cl (m, i) = e−blm if
i ∈ [0, τ ]. Nontraded industries are forced to produce locally all input varieties. Thus,
consumption in nontraded industries is cl (m, i) = e−η if i ∈ (τ , 1]. This implies the following
utility from consuming market goods:
WMl = − (1− τ) η − τ
∫ 1
0
blmdm. (4)
Equation (4) is valid for any configuration of borders. An increase in the share of traded
goods raises the consumption of newly traded goods. The size of this gain is proportional
to η for trade that does not cross a border, and it is proportional to η − β for trade thatcrosses a border. Removing borders also raises consumption. The size of this gain equals τβ
per border removed. These results are intuitive and play an important role in the analysis.
2.1.2 Government Type
There is a continuum of basic government varieties, x ∈ [0, 1]. A government for locality l
consists of a pair of density functions gEl (x) and gCl (x) defined over these varieties. Since
these functions are densities, gEl (x) ≥ 0, gCl (x) ≥ 0 and∫ 10gEl (x)dx =
∫ 10gCl (x)dx = 1.
We refer to the functions gEl and gCl as the economic and cultural types of the government
8
of locality l, respectively. These types constitute a complete description of the laws and
institutions that govern economic and cultural interactions within locality l.
We now introduce three assumptions about government services. The first is that each
locality has a different ideal cultural variety of government. We define and order the basic
varieties such that the ideal one for locality l is x = l. The value of government services for
locality l depends positively on how dense gCl is at x = l, that is, it depends on gCl (l).
The second assumption is that there are economies of scale in the provision of government
services. Building and maintaining a specific government reduces the overall provision of
government services by a total amount φ > 0. Localities that choose the same pair(gEl , g
Cl
)share this cost equally among them.
The third assumption is that there are economies of scope when cultural and economic
types of government coincide. Localities that choose gCl 6= gEl must pay a per capita cost of
κ > 0.
To formalize these assumptions, we write the utility derived from government services as
follows:
WGl = − δ
gCl (l)− φ∫ 1
0Igl=gmdm
− κIgCl 6=gEl , (5)
where δ > 0; Igl=gm is an indicator variable that takes value one if(gEl , g
Cl
)=(gEm, g
Cm
), and
zero otherwise; and IgCl 6=gEl is another indicator variable that takes value 1 if gEl 6= gCl , and
zero otherwise. The first term in Equation (5) says that the value of government services
for locality l grows with the density of its own specific ideal variety in the cultural type of
its government. The parameter δ measures the importance of preference heterogeneity. The
second term in Equation (5) says that the fixed cost of government declines with the number
of localities that share the same government. The parameter φ measures the magnitude
of these economies of scale. The third term of Equation (5) says that choosing different
economic and cultural types of government reduces the value of government services. The
parameter κ measures the magnitude of these economies of scope.
We next introduce a fourth assumption, namely, that having different economic types
creates borders that obstruct trade:
blm = βIgEl 6=gEm , (6)
where IgEl 6=gEm is an indicator variable that takes value 1 if gEl 6= gEm, and zero otherwise. The
idea, of course, is that disparity in economic laws and institutions makes trade more costly.
The parameter β is a measure of these costs.
9
2.2 Equilibrium Political Structure under Diplomacy
A political structure for the world is a set of governments for all localities, i.e.{gCl , g
El
}l∈[0,1].
Combining Equations (1), (4), (5) and (6), we obtain:
Wl = − (1− τ) η − τβ∫ 1
0
IgEl 6=gEmdm−δ
gCl (l)− φ∫ 1
0Igl=gmdm
− κIgCl 6=gEl . (7)
Equation (7) shows how political structure determines welfare and reveals the key trade-off
that underlies our theory. A desirable political structure should facilitate trade, accommo-
date preference heterogeneity and take advantage of economies of scale and scope. But these
goals cannot be achieved simultaneously and something must give.
To determine the equilibrium political structure, we must make assumptions about how
governments are chosen. A good starting point is the case in which localities are sovereign
and they freely choose their own economic and cultural types of government. Since there is
no heterogeneity within localities, their choices maximize the welfare of their representative
individual. Their choice of cultural type does not affect other localities. But their choice
of economic type does, since it determines borders and therefore trade costs. These policy
externalities provide incentives for localities to engage in diplomacy and negotiate political
contracts.
Localities can sign political contracts to share a government with other localities. We
refer to these contracts and the localities that sign them as countries. Formally, a country
is a set of localities that share the same economic and cultural types of government, i.e.(gCl , g
El
)=(gCm, g
Em
)for all l and m belonging to the country. Countries choose the average
ideal cultural type of their members:
gCl (x) =
1
Sif x ∈ country
0 if x /∈ country, (8)
where S is the combined measure of localities that belong to the country.
Countries can also sign political contracts to share a common economic type of govern-
ment. We refer to these contracts and the countries that sign them as (‘economic’) unions.
Formally, a union is a set of countries that have different cultural types of government, but
share the same economic type of government, i.e. gEl = gEm for all l and m belonging to the
10
union.8 Unions choose the average ideal type of their members:
gEl (x) =
1
Uif x ∈ union
0 if x /∈ union, (9)
where U is the combined measure of localities that belong to the union. As a result, gCl 6= gEl
for all l belonging to the union.9
How does the world organize itself into countries and unions? A natural benchmark is
that in which bargaining among localities is effi cient and delivers Pareto effi cient outcomes.
In this case, the equilibrium political structure under diplomacy is obtained by solving this
maximization problem: {gCl , g
El
}l∈[0,1] = arg max
∫ 1
0
ωlWldl, (10)
where {ωl}l∈[0,1] is a set of Pareto weights such that∫ 10ωldl = 1. Given all the symmetry
of this world, it seems reasonable to focus on the the case in which the bargaining process
treats all localities in the same way, i.e. ωl = 1. Sometimes this political structure is referred
to as the utilitarian welfare optimum.
To find this political structure, we proceed in three steps. First, we compute the welfare
WN generated by a world without unions:
WN = maxSN∈[0,1]
{− (1− τ) η − τβ (1− SN)− δSN −
φ
SN
}, (11)
where SN is the preferred country size in the absence of unions.10 This political structure
takes full advantage of economies of scope, and country size trades off preference heterogene-
8We could also define ‘cultural’unions analogously. But this is unnecessary since countries would neversign political contracts to share a common type of cultural government, and then choose different economictypes of government.
9We assume that both countries and unions choose the average ideal type of their members for simplicity.But it is not diffi cult to derive this as a result. No additional assumptions are needed to show that countrieschoose the average cultural and economic type of their member localities. To show that unions choose theaverage economic type of their member countries, we would need to assume some preference heterogeneityalso for economic type.10Throughout, we disregard the constraint that the number of countries, which in this case is 1/SN , must
be a natural number. Aside from this constraint, all localities prefer the same optimal country size, soany Pareto-effi cient equilibrium is symmetric. In Appendix A.3 we introduce this integer constraint andshow that the utilitarian welfare optimum remains symmetric and qualitatively analogous to the tractableapproximation we present here.
11
ity against both economies of scale and facilitating trade:
SN =
√φ
δ − τβ . (12)
The equilibrium size of countries in the absence of unions is increasing with economies of
scale (φ) and the importance of trade (τβ), and it is decreasing with preference heterogeneity
(δ). Equation (12) assumes that δ > φ+ β, so that there is enough preference heterogeneity
to ensure that countries are always smaller than the whole world.
Second, we compute the welfare WU generated by a world with unions. The cost of
forming a union does not change with its size, but its benefit does increase with size. Thus,
the equilibrium union is always the world union, i.e. U = 1. This allows us to write:
WU = maxSU∈[0,1]
{− (1− τ) η − δSU −
φ
SU− κ}, (13)
where SU is the preferred country size with a world union. This political structure gives
up economies of scope in order to remove borders and facilitate trade. Then, country size
trades off preference heterogeneity and economies of scale:
SU =
√φ
δ. (14)
The equilibrium size of countries with a world union is increasing with economies of scale (φ)
and it is decreasing with preference heterogeneity (δ). Country size is always smaller with
a world union than without. The reason is that the union removes one of the incentives for
country size, namely, facilitating trade.
The third step is to determine the equilibrium political structure as follows:
WF = max {WN ,WU} , (15)
where WF is the welfare obtained by a locality in this free world. If WN > WU , the
equilibrium political structure consists of the world being partitioned into countries of size
SN . If instead WN < WU , the equilibrium political structure consists of the world being
partitioned into countries of size SU and a world union. Naturally, in the knife-edge case in
which WN = WU , both solutions are equilibrium political structures.
12
A little bit of algebra shows that:
WF = − (1− τ) η − τβ −min{
2√φ (δ − τβ), 2
√φδ + κ− τβ
}. (16)
It is straightforward to see that the world union is preferred if and only if 2√φδ + κ− τβ <
2√φ (δ − τβ), hence for high values of τ , β and δ; and low values of φ and κ. A world union
is more useful if trade costs are low, the border effect is sizeable and there is substantial
preference heterogeneity. A world union is less useful if economies of scale and scope are
sizable.
2.3 Globalization and Political Structure
With these results at hand, we can now return to Figures 1 and 2 in the introduction and ask
again: Why did the first wave of globalization reduce the number of countries but did not
generate economic unions? Why did the second wave of globalization increase the number
of countries and led to the creation of economic unions?
To develop some intuition, Figure 3 plots WN , WU and WF as a function of τ . Note that
WF is the upper envelope of WN and WU , and it is depicted as a solid line. As τ increases,
the potential gains from trade increase and so does the incentive to remove borders. This
affects political structure in a non-monotonic way. In particular, there is a threshold level
τU such that WN < WU and there is no world union for τ < τU ; while WN > WU and there
is a world union for τ > τU . This threshold is interior, i.e. τU ∈ (0, 1), for intermediate
levels of economies of scope:
0 < κ < β − 2√φ(√
δ −√δ − β
). (17)
If economies of scope are negligible, the smallest amount of trade leads to the formation of a
world union. If economies of scope are prohibitive, the world union is never an equilibrium.
The comparative statics of this threshold follow directly from our analysis of Equation (16).
The larger is the border effect (β) and preference heterogeneity (δ), the smaller is τU . The
larger are economies of scale (φ) and scope (κ), the larger is τU .
Figure 4 shows how the equilibrium political structure changes with globalization by
plotting the equilibrium size of countries and unions. At low levels of globalization (τ ≤ τU),
expanding trade opportunities lead to an increase in country size. At this early stage of
globalization, the cost of reaping new gains from trade is a growing preference mismatch.
13
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0
0.9
tau
W
Figure 3: Globalization andWelfare. The figure shows how equilibrium welfare (WF ) changeswith globalization (τ). The black line is maximum welfare without a union (WN), the greenline with the world union (WU).
It is simply too expensive to create a world union given the small amount of trade. At
high levels of globalization (τ ≥ τU), the preference mismatch has grown too large and
expanding trade opportunities now lead to the creation of a world union. At this late stage
of globalization, the cost of reaping new gains from trade is the loss of economies of scope.
Indeed, the creation of a world union allows countries to revert to a smaller size and reduce
the preference mismatch. Further increases in τ have no effect on political structure.
The symmetric world neatly illustrates the non-monotonic response of political structure
to globalization. It is instructive to compare this result to the finding by Alesina, Spolaore
and Wacziarg (2000) that globalization always reduces country size. Their analysis differs
from ours in two crucial ways. The first one is that, unlike us, Alesina et al. assumed that κ is
prohibitive so that the world union is never an equilibrium and country size is determined by
Equation (12). The second difference is that, unlike us, Alesina et al. interpreted globalization
as a reduction in the border effect β, keeping constant the fraction of traded goods τ (which
was set to one). It follows directly from Equation (12) that a reduction in the border effect
reduces country size. In our model, the border effect is removed endogenously by the creation
of the union, but only when τ is suffi ciently high.
14
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
tau
lnS
Figure 4: Globalization, Countries and Unions. The figure shows how the world politicalstructure changes with globalization (τ). The black line is the size of each country, the greenline is the world union.
3 War and Conquest
In our baseline model we considered a world in which every locality can choose its own
government freely. Then, the equilibrium political structure is the outcome of free contracting
among equals. This constitutes a useful theoretical benchmark and an ideal state of affairs.
But it hardly reflects historical experience. Alongside diplomacy, war and conquest (or the
threat of it) have played a crucial role in shaping real-world political structure. Thus, we
want to know whether the possibility of war and conquest affects the relationship between
globalization and political structure. And if it does, we also want to know how and why this
happens.
We keep all assumptions as before regarding preferences and technology. But now we
consider an alternative rule to determine political structure. In particular, we assume that
the world contains “great powers”that are able to conquer other localities through war and
form empires. If some of these great powers choose to do so, the world is partitioned into
a set of empires where political structure is determined by war and conquest, and a set of
free countries where political structure is determined by diplomacy. We explain how this all
works next.
15
3.1 Empire-building
The world contains a finite set of π ∈ N identical “great powers”that are able to conquerother localities through war and form empires. Like a free country, an empire consists
of a set of localities that share the same economic and cultural types of government, i.e.(gCl , g
El
)=(gCm, g
Em
)for all l and m belonging to the empire. Unlike a free country, an
empire does not treat all of its member localities symmetrically. In particular, an empire
contains two distinct sets of localities: the metropolis and the colonies. Let E be the size of
the empire containing a metropolis of sizeM and colonies of size E−M . The key asymmetryis that the empire’s cultural type is the average ideal cultural type of the metropolis:
gCl (x) =
1
Mif x ∈ metropolis
0 if x /∈ metropolis. (18)
Since this implies that colonies have a welfare of WC = −∞, no locality becomes a colonyvoluntarily.
To build an empire of size E, a great power must find allies to build a metropolis, and
then wage war to conquer the colonies. A colonial war is successful if and only if the size of
the metropolis is large enough relative to that of the colonies:
M ≥ µE. (19)
The parameter µ ∈ (0, 1) provides the smallest size of a successful metropolis.
From the perspective of the metropolis, the upside of building an empire is that it forces
the colonies to adopt the average ideal government type of the metropolis. This facilitates
trade and generates economies of scale without creating preference mismatch. The downside
of building an empire is that waging war and holding the empire together reduces the utility
that the metropolis derives from government services by an amount ω > 0. This cost
captures the diversion of government resources from providing public goods in the metropolis
to waging colonial wars.
Localities that do not belong to empires remain sovereign and choose their political
structure through diplomacy. In particular, they form free countries as in the baseline
model.
16
3.2 Equilibrium Political Structure with War and Conquest
We now determine equilibrium political structure arising from the following three stages:
1. The great powers choose whether to wage war and build empires. Other localities
might become their allies, their colonies, or remain sovereign.
2. Localities that remain sovereign form countries by free and symmetric contracting, as
in our baseline model.
3. Empires and free countries can form economic unions.
We assume that great powers can successfully coordinate with each other on the creation
of their respective empires. Coordination ensures that great powers wage colonial wars
without ever clashing with each other. They agree on their separate spheres of influence, so
they can target disjoint sets of localities to conquer as their colonies. Moreover, the number
of great powers is small enough that all of them can find the desired number of localities to
be used as allies and colonies without having to fight each other.11
To solve for the equilibrium, we first study the incentives of great powers to build empires.
Given the choice of great powers, we then study the equilibrium political structure of the
remaining sovereign localities.
3.2.1 The great powers
Great powers must first decide whether to build an empire and become part of the metropolis
or to forego war. To do this, they compare the welfare of these two options. If the great
powers agree to refrain from waging war and instead jointly choose to form countries and
unions by free and symmetric contracting, the world equilibrium remains the one described
by the previous section. All localities, including the great powers, have welfare WF , which
is still given by Equation (16).
However, great powers may decide to wage war and form empires. In this case, the
welfare WE of a metropolis in an empire outside of an economic union is:
WE = maxE∈[0,1]
{− (1− τ) η − τβ (1− E)− δM − φ
E− ω
}s.t. M ≥ µE. (20)
11Historically, great powers have in fact agreed on such explicit partitions of the world, from the Treatyof Tordesillas in 1494 to the Berlin Conference in 1884.
17
Naturally, the constraint is binding and M = µE. From the perspective of the metropolis,
there is no reason to convert additional colonies into allies and “worsen” the government
type. The equilibrium size of the empire trades off preference heterogeneity against both
economies of scale and facilitating trade:
E =
√φ
δµ− τβ . (21)
The equilibrium size of empires is increasing with economies of scale (φ) and the importance
of trade (τβ), and it is decreasing with preference heterogeneity (δ). These comparative
statics are the same as for countries. Also, the smaller is the size of the metropolis relative
to that of the colonies (µ) the larger is the empire. We assume that δµ > φ + β such that
an empire never grows as large as the entire world.
Comparing Equation (21) to Equation (12), it is immediate to see that empires are larger
than peaceful countries, because the metropolis does not internalize the cost of the cultural
mismatch imposed on the colonies. Moreover, comparing WE to WF (i.e., Equations 20 and
16) in the case τ → 0 shows that diplomacy prevails in autarky if war is suffi ciently costly:
ω > 2√φδ(1−√µ). (22)
This condition implies that great powers do not wish to conquer colonies merely to compel
them to defray the fixed cost of government. The motivation for imperial expansion lies
instead in the desire to gain access to colonial markets without having to compromise the
great power’s preferred type of cultural government. As a consequence, the great powers
choose to forego warfare in autarky, when market access is worthless. When this condition
is satisfied, war may arise endogenously as a function of globalization, but it is not the
dominant strategy for any value of τ . To focus on this more interesting and realistic case,
from now on, we assume that Condition (22) is satisfied.
Consider now an empire part of an economic union. Since the benefit of forming a union
is increasing in its size, great powers will jointly agree to form the largest possible union.
Moreover, it is straightforward to show that when great powers want to form a world union
the remaining localities are always willing to join it.12 Hence, if the union is chosen, it will
be the world union. However, an additional implication of Condition (22) is that the great
12Intuitively, since free countries are always smaller than empires, they are always keener on joining aworld union and reaping the benefits of reducing barriers to international trade.
18
powers prefer to forego war if they wish to join an economic union that guarantees unfettered
access to world markets. Hence, economic unions including great powers will be peaceful.
In sum, welfare for great powers is WP = max {WE,WF}. When WE > WF , there are
π empires of size E.13 When WE ≤ WF , instead, diplomacy rules. While we know already
that peace prevails in autarky, great powers may choose to wage war at intermediate levels
of globalization. To see this, note that:
∂
∂τ(WE −WN) = β (E − SN) > 0. (23)
Rising globalization makes empires more appealing relative free countries because in equi-
librium they have larger markets. For the same reason, however, globalization also makes a
peaceful world union more appealing relative to an empire.
3.2.2 The free world
Consider now localities that are neither great powers nor part of an empire. If WF ≥ WE, as
we already discussed above, all localities have welfare WF and the world political structure
is identical to the case without war. IfWF < WE, instead, there are π empires of size E. The
analysis of the remaining 1 − πE sovereign localities, i.e., the “free world”, is quite similar
to that of the previous section. The welfare delivered by a free world without unions is still
described by Equation (11), and the associated equilibrium country size SN is still given
by Equation (12). There is however a new possibility. All localities that do not belong to
empires may form a union. If they choose to do so, it is again the largest possible one. But
now this is the union of all free countries in a world with empires. Since this union has a
combined size of 1− πE, the welfare of its localities is given by:
W̌U = maxSU∈[0,1]
{− (1− τ) η − τβπE − δSU −
φ
SU− κ}. (24)
Empires reduce the size of the free world and therefore the welfare delivered by an economic
union of free countries. Note however that equilibrium country size SU is still described by
Equation (14).
If WN > W̌U , the free world is partitioned into countries of size SN and there is no
economic union. If instead WN < W̌U , the free world is partitioned into countries of size SU
13We assume that great powers coordinate on forming the maximum number of empires rather than joiningeach other’s metropolises. This is feasible given our assumption πE < 1 for all τ .
19
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
1.5
1.4
1.3
1.2
1.1
1.0
0.9
tau
W
Figure 5: Contracts, Conquest and Welfare. The figure shows how equilibrium welfarechanges with globalization (τ). The black line is maximum welfare from contracts (WF ), thered line from conquest (WE).
and there is a union. Comparing Equation (24) to Equation (11), it is easy to see that the
union of free countries is preferred if trade costs are low (τ), the border effect is sizeable (β),
there is substantial preference heterogeneity (δ), and economies of scale (φ) and scope (κ)
are weak. These results were already obtained in the absence of empires, i.e. with πE = 0.
A new result here is that empires (πE) reduce the value of an economic union. The reason,
of course, is that they reduce its size.
3.3 Globalization and Political Structure Again
Let us now return to the analysis of the effects of globalization on political structure that
motivates our analysis. Figure 5 plotsWF andWM as a function of τ . In the most interesting
case that we plot, there are now two relevant threshold values, τE and τU . These thresholds
define three different stages of globalization with distinct equilibrium political structures.
Figure 6 depicts this three-stage evolution by plotting the equilibrium size of empires,
free countries, and unions. At low levels of globalization (τ < τE), the world contains only
free countries that grow in size with trade opportunities. There are no empires or unions.
As globalization proceeds, the size of countries grows and so does the preference mismatch.
When globalization crosses the first threshold (τE ≤ τ < τU), the preference mismatch has
grown too large and the great powers prefer to form empires. The latter allows the metropolis
20
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
tau
lnS
Figure 6: Countries, Empires and Unions. The figure shows how the world political structurechanges with globalization (τ). The black line is the size of peaceful countries, the red lineis the size of empires, the green line is the world union.
to impose their ideal type of government on the colonies. Thus, empires facilitate trade and
generate economies of scale at the cost of an unbounded preference mismatch in the colonies.
Empires are larger than countries and keep growing as globalization proceeds. Eventually,
globalization crosses the second threshold (τU < τ). At this point, preference mismatch has
grown too large even within empires. Empires collapse and countries revert to a smaller size.
A world union is created. After this, there are no further changes in political structure.
Naturally, it is possible for some configuration of parameters that the world skips one
or two of these stages. For instance, the second stage may not exist if the cost of war is
high (high values of ω and µ). Or the third stage might not exist if economies of scope are
strong (high values of κ). Another possibility not shown in the picture is that, before the
great powers decide to abandon imperial conquest and form the world union, all localities
that don’t belong to empires form a smaller free union. Such a free union is never optimal
if it is too small because there are too many empires (high values of π). In any case, our
objective is not to provide a detailed taxonomy of cases but instead to show that our simple
model is capable of helping us understand the relationship between globalization and political
structure.
21
4 World, Regions and Countries
The world so far lies in an abstract space in which all localities are symmetric and equidistant.
In reality, geography is much more complex. The world is made of continents and regions,
and more proximate areas tend to be more integrated, both economically and politically. We
can capture some of these aspects with simple modifications of our baseline model. Besides
the added realism, this extension will help us rationalize why the process of formation of
unions tends to be gradual and may start at the regional level.
4.1 Regions
Suppose that the world is divided into r ∈ N symmetric regions, each of them containing a
measure 1/r of localities. There is a measure τ r of goods that are traded only within the
region, among 1/r localities, and a measure τw of goods that are traded with all localities in
the world. As before, consumption of nontraded industries is cl(m, i) = e−η and consumption
of world-traded industries is cl(m, i) = e−blm . In industries that are traded only regionally,
instead, there is partial specialization: cl(m, i) = e−η if m and l do not belong to the same
region and cl(m, i) = e−blm otherwise. Thus, utility derived from consumption of market
goods in a locality belonging to region Rl is:
WMl = − (1− τw − τ rr) η − τw
∫ 1
0
blmdm− τ r∫m∈Rl
blmdm. (25)
Notice that borders within a region have a cost of (τw + τ r) β, while borders across regions
only cost τwβ. This is because the volume of trade is higher within than between regions. It
follows immediately that, other things equal, it is better to form countries (or unions) with
localities in the same region.
Another important aspect that we want to capture is the possible difference in the cost
of forming regional and world unions. To do so, we generalize our description of economies
of scope in the provision of government services. So far, we have assumed that the cost
of providing different economic and cultural types of government does not depend on the
identity of these types. This was a natural assumption, given the symmetry of the model.
However, once we introduce regions, it is equally reasonable to think that sharing government
types with localities within the same region is less costly than sharing them at the world
22
level. Hence, we now assume:
κ =
{κr if gEl (x) = 0 for all x /∈ Rl
κr + κw otherwise. (26)
The higher cost of sharing economic regulations at the world level may capture the higher
coordination and transaction costs when providing types that are too far apart.
4.2 Diplomacy in a World of Regions
We can now compare welfare across different political structures. As a first step, we focus
on the case without empires, i.e., when the cost of war is prohibitively high. Assume for
simplicity that√φ/(δ − β) < 1/r, which implies that countries are always smaller than
regions. If we identify regions with real-world continents, this seems to be the empirically
more relevant case, especially if we disregard colonial powers. Then, the welfare generated
by a world of countries is:
WN = maxSN∈[0,1/r]
{−(
1− τw −τ rr
)η − τwβ (1− SN)− τ rβ
(1
r− SN
)− δSN −
φ
SN
},
(27)
where optimal country size is still given by Equation (12) with τ = τw + τ r.
A world of regional unions delivers welfare:
WR = maxSU∈[0,1/r]
{−(
1− τw −τ rr
)η − τwβ
(1− 1
r
)− δSU −
φ
SU− κr
}, (28)
where optimal country size is still given by Equation (14) and we have already used the
result that the optimal size of a regional union is the entire region. Finally, welfare in a
world union is:
WU = maxSU∈[0,1/r]
{−(
1− τw −τ rr
)η − δSU −
φ
SU− κr − κw
}, (29)
with the same optimal country size SU .
Once again, the equilibrium political structure is the one associated with the highest
welfare. As in the benchmark model, for τ r = τw = 0, the world is made of countries only.
However, an increase in either τ r or τw, raises welfare in all types of unions relatively more
than in countries. Hence, if the cost of forming unions is suffi ciently low, then globalization
will change the equilibrium political structure from countries to unions.
23
But what kind of union will arise? ComparingWR andWU shows that the regional union
is preferred to the world union ifτwκw
<1
β
r
r − 1. (30)
Intuitively, the regional union is preferred when the additional hurdle of a global government
is high (κw) and when most of trade is regional, i.e., when regions are large (low r) and
world tradables are scarce (low τw). If κw > β(1 − 1/r), then the regional union always
dominates the world union and the latter will never appear. If instead κw < β(1 − 1/r),
regional unions may still arise first, but may be followed by world unions if τw becomes
suffi ciently high. Finally, since a world union facilitates trade in all traded industries, any
increase in τ = τw + τ r raises welfare in the world union weakly more than in the regional
union. It follows that regional unions may precede the world union but cannot follow it.
4.3 War and Conquest in a World of Regions
We now return to the model of war and conquest. If empires are suffi ciently few in number
and small in size to ensure that regions always contain free countries, then the analysis in the
previous section can be extended in a straightforward way to the case with regions. There is,
however, a different scenario that seems worth exploring. Suppose that all the great powers
are concentrated in one region and all the localities of that region are great powers. This case
corresponds to a world in which one area, which we call the “West,”has developed a superior
military technology. We now briefly sketch the equilibrium political structure focusing on
localities in the West.
The assumption that great powers can successfully coordinate to avoid conflict between
themselves implies that the West will be evenly split into imperial metropolises and each
empire will conquer colonies located in other regions. While localities prefer to form peaceful
countries within a region, great powers that are geographically proximate must seek far away
colonies to avoid clashing with each other. We also maintain the assumption that the world
is suffi ciently large that the great powers can always conquer their desired empires and that
the imperial metropolis does not extend outside the entire region.
The welfare WE of a metropolis in an empire outside of any economic union is:
WE = maxE∈[0,1/rµ]
{−(
1− τw −τ rr
)η − τwβ (1− E)− τ rβ
(1
r−M
)− δM − φ
E− ω
},
(31)
24
with M = µE, and the preferred size of an empire is:
E =
√φ
δµ− β (τw + τ rµ). (32)
Consider now unions. Note that, by definition, a regional union cannot include outside
colonies (or else the cost of forming it would be κr + κw). It follows that if great powers
decide to form a regional union, it will be of peaceful countries with corresponding welfare
WR. Moreover, under the maintained assumption that Condition (22) holds, world unions
are also ruled by diplomacy, so that they generate welfare WU . Once again, the equilibrium
political structure will correspond to WP = max {WN ,WE,WR,WU}.As in the previous section, globalization increases the benefit of war relative to peaceful
country formation. At the same time, however, globalization increases welfare in unions
more than in countries and empires. Hence, countries can be replaced by empires, and both
countries and empires can be replaced by unions.
Figure 7 shows how the equilibrium political structure changes with globalization, mea-
sured by τ = τw + τ r, in the most interesting four-stage scenario. At low levels of global-
ization, there are only countries composed of localities belonging to the same region. The
size of these countries is represented by black line. As τ increases, the great powers in the
West start to build large empires, conquering colonies in other regions. During these initial
stages, the size of countries and empires grow with globalization. At some point, however, τ
becomes so large that great powers prefer to form peaceful unions. Once the war technol-
ogy is dismissed, however, political integration is more valuable at the regional level. Hence,
cross-regional empires are replaced by regional unions. Finally, as globalization proceed even
further, regional unions are replaced by the world union. As in the previous section, depend-
ing on the values of parameter, it is possible that the world skips some of these stages. Rather
than considering all the possible cases, we next use the model to discuss various historical
episodes.
5 An Interpretation of Historical Experience
We conclude by using our analytical results to attempt a suggestive narrative of the polit-
ical evolution of modern Europe (and the world). Since the late Middle Ages, European
sovereign states on average grew in size until the end of the 19th century, when this trend
was dramatically reversed. For example, Kitamura and Lagerlöf (2015) show that border
25
0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
2.0
1.5
1.0
0.5
0.0
tau
lnS
Figure 7: Countries, Empires and Regional Unions. The figure shows how the world politicalstructure changes with globalization for the case τ r = τw = τ/2. The black line is the sizeof peaceful countries, the red line is the size of empires, the brown line is the regional unionand the green line is the world union.
areas declined monotonically from 1500 to 1900, and then started to increase. Our model
seems particularly appropriate to explain this evolution. Medieval Europe was fragmented
into hundreds of small states at a time when trade was insecure and limited to few commodi-
ties. The early modern period saw important changes in both the economic and the political
organization of the continent. With the Commercial Revolution, trade began to flourish and
the feudal system started to be replaced by a smaller number of countries of growing size.
While in 1600 there were 112 sovereign states in Europe and the Near East, at the beginning
of 1800 the number had fallen to 79.
The Industrial Revolution gave trade an even more prominent role and triggered ma-
jor changes in socioeconomic conditions that ultimately made the rise of the nation state
possible. Trade expansion was enabled by the introduction of canals, improved roads and
railways. At the same time, the high degree of political fragmentation at the time of the
Congress of Vienna (1815) was followed by the unification of Germany and Italy (1871) and
the further consolidation of other nation states. The economic rationale of building large
internal markets was especially evident in the case of German unification, which started
with the formation of a custom union (Zollverein) and had as a major consequence the
drastic improvement in transportation infrastructure. This process of political centralization
culminated at the beginning of 1900, when Europe was dominated by just 28 independent
26
Figure 8: Europe after the Congress of Vienna (1815)
states.
Yet, the twentieth century marks a turning point. It saw the rise of international organi-
zations both at the global level, such as the League of Nations, and at the regional level, such
as the European Community. One of the key objectives of many of these supra-national or-
ganizations was precisely to promote free markets. Simultaneously, Europe entered a stage
of political fragmentation, with the number of independent states growing to 58 in 2000.
This pattern of an initial decline and subsequent increase in the number of countries is not
confined to Europe only. For instance, the number of African countries fell from 36 in 1816
to 4 in 1914, to rise again to 51 in 2000. Similarly, in South-East Asia, this numbers changed
from 37 to 4 and then 20 in the years 1816, 1914 and 2000, respectively.14 However, to better
interpret the political evolutions in these regions, it is important to bring conflict into the
picture.
Our model of war and conquest seems broadly consistent with the rise and fall of colonial
14The number of countries is taken from Butcher and Griffi ths (2013).
27
Figure 9: Europe before World War I (1914)
empires. In our theory, empires are built to extract trade surplus from the colonies and
disappear when the union is formed to foster free markets. According to historians and in
line with this view, one of the key driving forces behind colonial expansion was the desire to
secure trade and access to scarce resources in an era of revived commerce, but when mercan-
tilist practices where common. The scarcity of land and the desire to avoid powerful rivals
induced European great powers to expand by conquering territories overseas. Despite some
notable setbacks, colonialism continued to grow prior to World War I and finally collapsed
after World War II. The sharp decline of empires started after the creation of international
agreements aimed at promoting economic cooperation. This is no coincidence. In the words
of Spruyt (2005) and Rosecrance (1986), empires dissolved, often peacefully, because the
gains through commerce displaced gains through territorial acquisition.15 There is also evi-
dence that international organizations played a direct role in the process of decolonization.
For example, in 1960 the UN General Assembly voted the Declaration on the Granting of
15Bonfatti (2012) also attributes the fall of empires to the growing importance of trade between industrialcountries relative to trade with colonies.
28
Figure 10: Europe Today (2014)
Independence to Colonial Countries and Peoples.
Focusing on size, the model shares with Alesina and Spolaore (2003) the prediction that
empires should be larger than democratic countries, a result which is confirmed by a quick
look at Figure 2. Moreover, the model suggest that countries may form and grow for the
desire to increase military might and build an empire or embark into colonial adventures.
This is indeed one of the recognized reasons behind the unification of Germany. Interestingly,
our theory also suggests that great powers switch to the union at higher levels of globalization
than consensual countries.16 Consistently, Figure 2 shows that size started to fall earlier on
for countries than for empires. Finally, the model predicts conflict to initially increase with
globalization and then fall drastically after the formation unions. Data on changes of borders
from Correlates of War seem supportive. The percentage of peaceful changes of borders fell
from 70% in the period 1816-1900 to 62% in the years 1901-1950, and then rose to 89% in
the period 1951-2008. Moreover, promoting peace by tightening economic integration was
16Formally, the emergence of empires unambiguously retards the creation of the world union. Moreover,unions of free countries may emerge earlier, with empires joining later on.
29
among the explicit goals of the European Union and the WTO.
The model can also be used to interpret the foundation and growth of the United States.
Improvements in transportation technology and the desire to create a large internal market
were important factors in its westward expansion. The abundance of land made it possible
to create one of the largest countries in the world, without the need to seek far away colonies.
Despite its size, the United States avoided the phase of collapse and political fragmentation
by choosing an institutional system with multiple levels of government. In this light, the
experience of the United States follows the main pattern predicted by our theory: the creation
and expansion of the federal government, which can be interpreted as a regional union,
coincided with the fragmentation and loss of political power of individual states.
After the Declaration of Independence, the borders of the original thirteen states extended
up to the Mississippi river while the remaining land was occupied by French and Spanish
colonies (later on part of Mexico) and by many tribes of native Americans living essentially in
autarky. As the federal government acquired land and built roads westward, its territory was
gradually fragmented into the fifty states. This process followed a common pattern. First,
new land was annexed as large “territories;” subsequently this land was broken into new
states. Federal expansion was followed not just by the creation of new states, but also by the
break-up of existing ones. For example, the former Republic of Texas (an independent nation
until 1846) encompassed large parts of current Oklahoma, Kansas, Colorado, Wyoming and
New Mexico; similarly, Georgia, Massachusetts, North Carolina and Virginia all lost land to
form new states.
Finally, our theory has been motivated by modern and contemporary political and eco-
nomic events because our model of trade and globalization seems especially suited to study
the period after the Industrial Revolution. Yet, some of its key implications seems consis-
tent with ancient history as well. For instance, several historians stress the importance of
trade and market size for the expansion of countries. According to Pirenne (1925, 1939),
the Roman civilization was heavily dependent upon Mediterranean trade and it collapsed
when trade ended with the Arab conquest.17 In his view, the cutting of major trade routes
forced individual regions into self-suffi ciency and this contributed to the consequent decline
and fragmentation of Western civilization into the Middle Ages.
17Similary, Friedman (1977) argues that trade increases the value of land and hence promotes territorialexpansion.
30
6 Conclusion
In this paper, we have studied how the forces of globalization contribute to shape the world’s
political structure. Our theory has shown that the expansion of trade opportunities can help
explain two salient puzzling phenomena in recent history. First, the rise and subsequent fall
in the size of countries observed during the 19th and 20th century. Second, the seemingly
contradictory trends towards more political integration across countries and more political
fragmentation within countries in the second half of the 20th century. Our theory is broadly
consistent with a variety of historical episodes. Despite its simplicity, our model has proved
capable of providing a remarkably rich picture. Yet, there are several important factors
that we have deliberately left aside. We now briefly mention three that seem particularly
promising for future research.
First, in this paper we have focused on economic globalization as an expansion of trade
opportunities. However, in reality globalization is a much more complex process that also
affects cultural preferences. If cultural globalization lowers the preference for heterogeneity,
it will also reduce the cost of removing borders. Hence, cultural globalization may reinforce
political integration, but may also lower the value of economic unions. The equilibrium polit-
ical structure may then be the result of a race between economic and cultural globalization.
In a similar vein, cultural preferences may be affected by the political choices. For example,
historically governments have often taken actions aimed at homogenizing their populations
(Alesina and Reich 2015).
Second, we have modeled economic unions as agreements aimed at facilitating trade.
Although this approach is both simple and realistic, it abstracts from another important role
of unions, namely, to solve cross-border externalities associated with domestic government
activity (Alesina, Angeloni and Etro 2005). Since globalization is likely to exacerbate such
policy externalities (Broner and Ventura 2011; Epifani and Gancia 2009), it increases the
value of forming unions. However, in this case international agreements must be properly
designed to eliminate any incentive for individual countries to free ride.
Finally, our concept of locality abstracts from internal heterogeneity both along cultural
and economic lines. Yet, historical experience suggests that internal conflict has played a
role in many processes of country formation and break-up (Bolton and Roland 1996, 1997).
It would be interesting to see how globalization also affects political structure through its
effect on domestic heterogeneity and conflict.
31
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A Appendix
A.1 Data Sources
The trade share reported in Figure 1 is merchandise exports as percent of GDP in 1990
prices, from Maddison (1995, 2001). Maddison provides trade data for selected countries in
the years 1820, 1870, 1913, 1929, 1950, 1973 and 1998. To avoid compositional effects, we
report the value of merchandise export as a share of GDP for the set of countries with data
for all the years (Austria, Belgium, France, Italy, Spain, Switzerland, the United Kingdom
and the United States). The trade share computed using the data for all available countries
in every year is very similar to the one displayed in Figure 1.
The number of countries is reported for the same years. Data on the number of countries
in the twentieth century is not very controversial. For the nineteenth century, however,
some leading conventions grossly underestimate the number of countries. For example, the
“International System”developed by Singer and Small (1966) and adopted in the Correlates
of War project or in the Cross-National Time-Series Data Archive, only includes countries
with international recognition. In particular, prior to 1920, the criteria to be recognized as an
independent country were to have population greater than 500,000 and have had diplomatic
missions at or above the rank of charge d’affaires with Britain and France. Clearly, this
definition is too strict for our purposes, which require the identification of even relatively
small political units living in economic and political autarky. We follow Butcher and Griffi ths
(2013) who recognize the problem and offer alternative sets of criteria to identify the number
of countries between 1816 and 2011.
The number of WTO members is from the WTO’s website.
The size of countries and empires displayed in Figure 2 is from the Cross-National Time-
Series Data Archive (CNTS). It provides data on contiguous territorial area in thousand
square miles for all countries existing in a given year according to the International State
System. In a few instances, missing data have been imputed cross-checking major territorial
changes from other sources (China and Persia before 1860). Area of empire is provided
for a consistent sample of 13 countries: Austria-Hungary (later Austria), Belgium, France,
Germany (Prussia), Italy (Sardinia), Japan, Netherlands, Portugal, Russia, Spain, Turkey
(Ottoman Empire), United Kingdom, and United States. For these countries, empire area
includes “overseas” territories (i.e., colonies). Data for the two modern wartime periods,
1914-1918 and 1940-1945 (1938-1954 for Empires) are missing.
European political maps where drawn using the online software GeaCron (http://www.
35
geacron.com). This software provides a geo-temporal database that can be used to draw
geopolitical maps of any region in the world, in any given historical time period. The
number of independent states in Europe and Near East reported in Section 5 is taken from
Euratlas-Nüssli (http://www.euratlas.com).
A.2 Computing Equilibrium Consumptions
Locality l maximizes
WMl =
∫ 1
0
∫ 1
0
ln cl (m, i) dmdi (A1)
subject to the following budget constraint:∫ 1
0
∫ 1
0
pl (m, i) [cl (m, i)− ql (m, i)] dmdi ≤ 0, (A2)
where ql (m, i) and pl (m, i) are the production and price of input m of industry i in locality
l. The productions ql (m, i) must be consistent with available technology as described in
the text. Since individuals are atomistic, they take prices as given in their maximization
problems.
We claim now that equilibrium prices are given as follows:
pl (m, i) =
{blm if i ∈ [0, τ ]
η if i ∈ (τ , 1]. (A3)
To prove this claim, note first that all localities spend the same on each input: di. Thus,
the world share of spending on each input is also di. Let world income be Y . Then, the
spending on each input is Y di. We next examine productions. Consider first nontraded
industries. Our assumptions on preferences and technology ensure that all localities use the
specialization technology and produce η−1di units of each nontraded input. Thus, the value
of the production of each nontraded input is (η/η)di =di. Consider next traded industries.
The assumption that blm < η ensures that all localities prefer to use the technology based on
specialization. Thus, the value of the production of each traded input is 1× di = di. Since
world income is Y = 1, spending in each input is also di. This proves our claim.18
18It is straightforward to show that this equilibrium is unique. First, rule out variation in the prices oftraded inputs since this would generate excess demand (supply) of cheap (expensive) varieties. Second, ruleout that the relative prices of traded and nontraded varieties be above (below) blm/η since this would leadto an excess demand (supply) of nontraded inputs.
36
With these prices at hand, we can compute the equilibrium productions and consumptions
described in the text.
A.3 Dealing with Integer Constraints
A world without unions consists of N∗ ∈ N countries of measure Sn > 0 each, such that∑N∗
n=1 Sn = 1 and utilitarian social welfare is W =∑N∗
n=1 SnWn (Sn).
The welfare function
Wn (Sn) = − (1− τ) η − τβ (1− Sn)− δSn −φ
Sn(A4)
is concave in Sn and increasing at Sn = 0. For all τ < (δ − φ) /β it has a unique maximum
at Sn = SN .
Pareto effi ciency then requires that either Sn ≤ SN for all n or Sn ≥ SN for all n, or
else some localities could leave a country with excessive size Sn > SN and join another with
insuffi cient size Sn < SN , raising the welfare of every locality in both countries.
Utilitarian welfare maximization requires all countries to have the same size. If Sm >
Sn > SN then transferring the marginal locality from m to n not only raises its welfare,
but it also raises the welfare of Sm localities by more than it lowers the welfare of Sn < Sm
localities. Likewise if Sm < Sn < SN .
Therefore, once integer constraints are taken into account, the utilitarian welfare optimum
without unions is a partition of the world into a number
N∗ = arg maxN∈N
{τβ
N− δ
N− φN
}(A5)
of identical countries. The maximand has strictly decreasing differences in (N, τ) because
for any τH > τL and and NH > NL,
W (NH , τH)−W (NH , τL) = (τH − τL)β
NH
< W (NL, τH)−W (NL, τL) = (τH − τL)β
NL
. (A6)
Thus, the welfare-maximizing number of countries N∗C is decreasing in τ in the sense of
monotone comparative statics. It is likewise decreasing in β, and increasing in δ and φ.
By the same reasoning, the utilitarian welfare optimum with unions is a partition of the
37
world into atomistic countries joined into a number
N∗U = arg maxN∈N
{τβ
N− φN
}(A7)
of identical unions.
38